It is time to smash the myth industry doesn't need government innovation

From MRI scanners to the Moon, the state has been crucial in pushing society forwards.

We now have a new government and a new opportunity to create an enduring legacy in the industrial development of the UK. But to do this, we need to abandon the traditional perspective of what a government can do to foster innovation, normally described as ‘getting out of the way’.

That perspective reflects a poor understanding of how innovation happens. In fact, the idea of the government as a mere facilitator, administrator and regulator needs to be corrected. In all countries that owe their growth to innovation – not simply natural resources – the government has been a key, essential partner.

Without government involvement, entirely new markets and sectors such as the internet, cleantech (recycling, renewable energy and the like), nanotechnology and biotechnology simply wouldn’t exist. We need to move beyond the simplistic view of ‘industry great, government bad’ and encourage more of this government-led innovation. This means rethinking the role of the state, as well as the terms of private sector involvement.

The state and Silicon Valley

In addressing societal challenges such as climate change, youth unemployment and an ageing population, this new government has to recognise that it is the only body that can lead, not by fixing market failures but by actively creating markets.

For example, despite the common view that the shale gas boom was driven by entrepreneurs, it was the US federal government that invested heavily in the technologies that unleashed it. In 1976, the Morgantown Energy Research Center and the Bureau of Mines launched the Eastern Gas Shales Project, which demonstrated how natural gas could be recovered from shale formations. That same year, the federal government opened the Gas Research Institute, funded through a tax on natural gas production and spent billions of dollars on research into shale gas.

Similarly, in Silicon Valley, the US government funded many of the innovations behind the information technology revolution. The iPhone, often heralded as the perfect example of what happens when a hands-off government allows entrepreneurs to flourish, relies on features that were publicly funded. GPS began as a 1970s US military programme and even Siri, the iPhone’s voice-recognising personal assistant, can trace its lineage to the US government.

In the UK the MRI scanner was derived from work completed by the Medical Research Council. If we fail to tell the public side of the story, future government-funded research is at risk but, more significantly, the sources of innovation and the resulting private company wealth will vanish.

Government spending on innovation tends to be assessed by the private sector in the wrong way - market failures are identified and government investments are proposed in response (think electrification, telephones or airlines). This leads to the perception that the public sector is an inefficient version of the private sector and that it crowds out private investment.

Instead, we should evaluate an investment on whether it taught workers new skills and led to the creation of new technologies, sectors or markets. When it comes to government spending on pharmaceutical research, for example, it may make sense to move past the private sector’s focus on drugs and fund more work on diagnostics, surgical treatments and lifestyle changes. They could then move any future investment in drugs to reward outcomes through the healthcare system, reducing both private and public sector costs.

Government as venture capitalist

But there is also a need to learn from failed investments and this new government should pay as much attention to the business school topics of strategic management and organisational behaviour as private companies do. Government interventions don’t always get it right and an ability to manage the portfolio and stop projects that are not delivering is important.

We should have a focus on government profit and loss. Since governments often invest during the riskiest parts of the innovation process, there needs to be a way for them to experience the rewards and not just the risks of their investments. The problem is that, unlike venture capital firms, traditionally governments have been saddled with the costs of failure while earning little from the successes. Economists may argue that the government receives a return on its investments by taxing the resulting profits. However, without globally transparent tax arrangements there is no guarantee of this payback.

Governments should instead consider attaching strings to their loans or even retaining equity in the companies it supports. Some countries adopted this model long ago, for example, the Finnish Innovation Fund was an early investor in Nokia’s transformation from a rubber company into a mobile phone giant. Other government organisations such as the Department for International Development’s International Finance Corporation show that it is possible to secure a return on investment and to re-invest it in future developments.

If we accept there is a role for more proactive government, the key question is then how can new industrial landscapes be created? Countries such as China, Denmark and Germany have all settled on their next mission: green energy. But the green energy revolution will require investment - not just in wind energy, solar power and biofuels, but also in new engines, new ways of more efficiently maintaining infrastructure and new ways of making products last longer. A good example of how this can be achieved can be seen in NASA’s moon mission which required the interaction of many different sectors, from rockets to telecommunications and textiles.

What next?

Accordingly, the new Conservative government should take its cue from the venture capital world and diversify its portfolio, spreading capital across many different technologies and enterprises. To achieve this three things need to happen:

1. Industry needs to put away the childish and simplistic attitude that government interventions bring more trouble, when in truth they know their enterprises exist only when they are actively partnering with the state, and that this partnering means taking the bad with the good (as it would with any other form of partnership).

2. Government needs to move its interventions from facilitation to active management of portfolios and ensure that they secure a return on investment.

3. We need to create new commercial models that allow that return on investment to government so that it can reinvest in our education and healthcare systems.

It is time for all of us to abandon the current obsession with limiting the state’s intervention to fixing problems after they have occurred and smash the popular myth that the government doesn’t innovate.

Colm Reilly is PA Consulting Group's head of economic development and managing director of UKTI's investment services

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